Who should have oversight of the cryptocurrency market?
Nicole Kalajian is a securities and commodities Attorney at Stradley Ronon. She has extensive experience engaging with United States regulators, particularly the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC), as they navigate cryptocurrency and blockchain technology. Nicole specializes in private fund offerings for entrepreneurs and investment managers. She helps launch hedge funds, commodity pools, private equity funds, venture capital funds, real estate funds, cryptocurrency funds, socially responsible investment vehicles, as well as various other private offerings.
Hehmeyer Trading + Investments sat down with Nicole to talk about what it’s like working with a product primarily regulated under two jurisdictions, whom she thinks will ultimately maintain regulatory authority and difficulties fitting new inventions into old regulatory guidelines.
Working with Regulators
“Blockchain and cryptocurrency regulation fell into my lap because it intersects with my background in securities and commodities laws,” she said. “My clients oftentimes have a great blockchain idea but are in need of funding. I will talk them through their options, like a private fund raise or a public offering.”
Nicole also helps her clients determine which registrations, if any, they will need to be compliant with U.S. regulations. “I assist with both SEC and CFTC registrations. The CFTC has been very clear in stating its position that all cryptocurrencies are commodities,” said Kalajian. “The SEC has been less clear, directing us instead to a 1946 Supreme Court case to determine for ourselves if a transaction is a security or not.”
Kalajian is referring to the U.S. Supreme Court case against the Howey Company. This case spawned what is now commonly referred to as the “Howey Test.” Application of the test seeks to determine whether a certain transaction qualifies as an “investment contract” and thus whether it is ultimately to be deemed a “security.”
“It’s hard to fit new inventions into old rules,” Nicole said. “The SEC said they will provide better guidance in 2019, so we are waiting to see what that will look like. My guess is that it will be a restatement of the Howey Test, along with some blockchain specific examples.”
The Digital Assets Working Group
Nicole also is a Founder of the Investment Network, which is comprised of professionals dedicated to expanding their network and knowledge of the investment industry. She is also a Founder of the Investment Network’s subgroup, The Digital Assets Working Group (DAWG). DAWG was launched early 2018 and has already grown to over 200 members. DAWG has invited U.S. regulators, such as the CFTC’s Jeff Gomberg and Michael Frisch as well as Ed Dasso from the National Futures Association (NFA), to speak at the group’s meetings.
“I was getting a lot of the same questions from various people, such as: how to launch an initial coin offering (ICO), how to get involved in the blockchain space, how to structure private offerings, how to value blockchain and cryptocurrency investments, who could serve as a qualified custodian, etc. Instead of meeting with people individually, I decided to host quarterly meetings for everyone where we could discuss hot topics relating to blockchain and cryptocurrency investments – particularly from a legal perspective, which I did not think was being aptly served,” she said. “There were a lot of attorneys out there that knew nothing about securities and commodities laws, but were trying to assist with ICO launches. It was actually fairly scary and unfortunately a lot of such offerings were deemed to be illegal.”
DAWG has also brought in trading firms to share their unique perspective on the crypto market.
“We’ve discussed whether the CFTC is correct in its determination that cryptocurrencies are commodities, and how that outcome intersects with commodities traded on exchanges and via leverage.”
Another topic the group tackled is whether a new, single authority should regulate cryptocurrencies, rather than the currently shared responsibilities of the SEC and CFTC. For this, Nicole brought in U.S. bitcoin exchange Gemini to discuss its efforts in creating the new Virtual Currency Association (VCA). Nicole believes that the creation of a separate regulatory authority, specifically tasked with cryptocurrency regulation, might be a good idea.
“Currently, it is challenging to have a product that is overseen by two different regulators, each of which has their own separate regulatory and compliance requirements. However, on the other hand, having a new authority charged with cryptocurrency regulation, might result in further regulatory burdens for asset managers,” she said. “A hedge fund manager, for instance, might want to trade U.S. equities, commodity options and cryptocurrencies. However, if we added a third regulator - specific to cryptocurrencies - this would result in the adviser being subject to oversight by three different regulators in connection with its trading activities. As a result, perhaps a better outcome would be for the VCA, or similar organization, to become a self-regulatory arm of the SEC, similar to the NFA with the CFTC. This could help save the SEC’s resources (i.e., taxpayer money) and allow the industry to be regulated by those members actually participating in the space.”
A Good Blockchain Investment
DAWG has exposed Nicole to a plethora of blockchain ideas that are in need of investor funding. “A good blockchain idea should solve a real-world problem. For instance, coming up with a creative idea that will revolutionize an already existing but inefficient process,” she said. “Also, it is very helpful if the team is already experienced in the industry that they seek to revolutionize. Having real industry experience sets teams apart.”
Her final perspective was great advice for all with budding blockchain ideas and cryptocurrency start-ups. “The team needs to be open to working with regulators. In the end, not working with regulators will harm you because you won’t be able to go mainstream,” she said. “A lot of start-ups went offshore at first but now realize that they will need to follow U.S. guidelines if they want U.S. investors, which is where a lot of the real investment money and interest is at.”
The intersection of blockchain technology and securities/commodities regulation has brought together U.S. regulators, lawyers, traders and entrepreneurs in an effort to better understand this nascent market. As authorities work on providing clarity and guidance, one thing is for sure – it’s best to work with them than try to skirt around them.
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